The purpose of activity based costing and management (ABC/M) is to link company processes, activities, and products with company costs and performance. More specifically, ABC/M provides quantitative answers to how much money or resources were consumed by specific activities, and how these activities translate to specific cost objects or products. Among ABC/M benefits is the ability to trace and assign costs based on cause and effect relationships. ABC/M methodology gives accurate cost values, helps explain which processes/activities drive the cost levels, and provides analytical insight into current and future operations.
A cost flow model, such as an ABC/M model, is a multi-dimensional directed graph. It depicts how money flows in an enterprise. The nodes in the graph represent the resource, activity, or cost object accounts. The edges in the graph typically have a percentage on them, which defines how much money flows from a source account to a destination account.
For example, in a company money may flow through many paths, and the linkage between origin and destination can therefore become murky. Activity-based costing and management systems show the flow, and can compute multi-stage partial contributions. However, traditional methods for determining the cost of reciprocal relationships (e.g., a step down method, a simultaneous equations method, etc.) do not represent the reality of the business situation and can result in cost calculations that appear abnormally large due to the effects of self-contributions and double-counting.